Exchange controls and exchange rate policy in the South African economy¶
Brian Kahn (1987). Exchange controls and exchange rate policy in the South African economy. Social Dynamics 13(1). Routledge (Informa).
| Type | journal article |
| Scope | Economics and economic history of apartheid |
| Method | policy analysis |
| Period studied | 1960–1986 |
| Regions | South Africa |
| Themes | macro fiscal finance debt, sanctions divestment, business and state, labour markets wages, manufacturing industrial policy, agriculture land, comparative theory |
| Citation key | kahn1987 |
Argument¶
Kahn argues that South Africa's balance of payments is exposed to two kinds of shock: gold price movements on the current account and political crises on the capital account. Exchange rate policy has had a systematic downward (undervaluation) bias that protects low-import-content exporters, mining and agriculture, and shifts income from wages to profits. He criticises the De Kock Commission's case for liberalising exchange controls. Liberalisation encouraged short-term foreign borrowing and capital flight, and it relies on access to world capital markets that closes precisely in crises (1976, 1985). He compares this with the failed Southern Cone and Israeli liberalisations, and concludes that liberalisation is inappropriate for a country prone to political crises.
Evidence and method¶
South African Reserve Bank Quarterly Bulletins (BOP, reserves, foreign debt tables and figures), De Kock Commission interim (1978) and final (1984) reports, the Kleu Study Group report (1983), Euromoney (Grant 1985), the Nedbank appraisal, and secondary theoretical literature (Diaz-Alejandro, Krugman and Taylor, Khan and Ul Haque).
Place in the debates¶
- Exchange control liberalisation vs retention (De Kock Commission vs critics) (see Finance, capital flight, the 1985 debt crisis and banking). Opposes liberalisation. Controls protect reserves in crises, and liberalisation brought debt build-up, capital flight and a credibility loss when controls were reimposed in 1985.
- Distributional effects of exchange rate policy (wages vs profits) (see Finance, capital flight, the 1985 debt crisis and banking). Argues that an undervalued or depreciating rand redistributes income from wages to profits and benefits mining and agriculture over import-dependent manufacturing.
- Market-oriented monetary and exchange reform vs state management of the capital account (see Finance, capital flight, the 1985 debt crisis and banking). Sceptical of the market mechanism in a country facing political and terms-of-trade shocks, citing the Latin American Southern Cone experience.
Findings¶
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Gold dominates exports, so gold price shocks drive current-account adjustment. (p. 3)
During the 1980's, approximately 70% of exports (excluding gold) have been agricultural and mineral, with gold alone averaging 47% of total exports.
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Reliance on Eurocurrency loans for state infrastructure raised the share of indirect investment and increased vulnerability. (p. 4)
increase in the proportion of indirect investment to total foreign investment from 32 percent in 1970 to 61 percent by 1984.
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Capital account shocks follow political crises and restrict access to loans, forcing deflation. (p. 4)
Such shocks occurred in the aftermath of Sharpeville (1960), Soweto (1976) and again after the recent debacle in 1985.
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Depreciation inflated the rand value of foreign debt sharply in 1983-84. (p. 6)
Between 1983 and 1984 debt rose by 6,6 percent in dollars, but because of the currency depreciation the rand value of this debt increased by 65,6 percent
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The exchange rate policy bias favours profits over wages. (p. 6)
Given the bias towards depreciation rather than appreciation in the conduct of South African exchange rate policy, such a stance tends to discriminate against wages in favour of profits.
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Exchange rate policy protects mining and agriculture, politically powerful export sectors. (p. 7)
Clearly mining and agriculture benefit most from a depreciation. Given the strength of the farmers as a political pressure group
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Lax regulation of private foreign borrowing in 1981-85 raised short-term debt and bunched maturities before the 1985 crisis. (p. 8)
between 1980 and 1985 total foreign debt increased from $ 16,7b to $27b and the proportion of short term debt to total debt increased from 49,1 percent to 72 percent.
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Evidence of exchange control evasion after Soweto. (p. 9)
the rise in the 'error and unrecorded transactions' item of the balance of payments from R77m in 1975 to R585m in 1977.
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The reimposition of controls in 1985 undermined the credibility of liberalisation. (p. 9)
Credibility formation is an asymmetric process: once eroded, it is hard to restore.
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Liberalisation is judged inappropriate and not an option for the foreseeable future. (p. 10)
the Southern Cone countries, Israel and South Africa have all reversed these policies in time.
Evidence ledger¶
Sources used¶
| Source | Kind | Period | How used |
|---|---|---|---|
| South African Reserve Bank Quarterly Bulletins (current and capital accounts of the balance of payments, 1967-1986) | official statistical series | 1967-1986 | Supplies the series plotted in Figure 1 to show the current and capital accounts moving in opposite directions. |
| South African Reserve Bank Quarterly Bulletins (net and gross foreign exchange reserves, 1968-1986) | official statistical series | 1968-1986 | Supplies Figure 2 showing changes in net and gross gold and foreign exchange reserves, with falls in 1976, 1981 and 1985. |
| Real and nominal rand effective (trade-weighted) exchange rate index, 1975-1986 (Figure 3) | official statistical series | 1975-1986 | Shows that the real and nominal rates appreciated with the rising gold price in 1980 and 1982 and depreciated after the 1984 political events. |
| Balance of payments item 'error and unrecorded transactions', 1975-1977, and gross gold and foreign exchange reserves, September 1977 | official statistical series | 1975-1977 | Used as an indicator of exchange control evasion after the 1976 unrest. |
| De Kock Commission Interim Report, 'Exchange Rates in South Africa' (RP 112/1978) | commission or official report | 1978 | Establishes the shift to variable dollar pegging and the Commission's position on exchange rates and controls. |
| De Kock Commission Final Report, 'The Monetary System and Monetary Policy in South Africa' (RP 70/1984) | commission or official report | 1984 | Provides the Commission's arguments against exchange controls, which the paper quotes and critiques, and evidence for the downward bias in exchange rate policy. |
| Franzsen Commission Report (1970) | commission or official report | 1970 | Contrasts the 1970 case for maintaining exchange controls with the later De Kock position. |
| Kleu Study Group, Report of the Study Group on Industrial Development Strategy (1983) | commission or official report | 1983 | Shows that manufacturing is the highest net user of foreign exchange and has the highest import content in its exports, which limits its gain from depreciation. |
| Grant, C. (1985) 'The Banks Abandon South Africa', Euromoney (December) | newspapers periodicals | December 1985 | Source of quoted statements by bankers and de Kock on the Reserve Bank's lack of information on corporate foreign debt and the failure of controls. |
| Nedbank (1983) South Africa: an Appraisal, Nedbank Group Economic Unit | company records or reports | 1983 | Source of Chris Stals's statement that abolition of the Financial Rand System was permanent, used to show the credibility loss when controls were reimposed. |
| Kahn, S. B. (1987) 'Import Penetration and Import Demands in the South African Economy', unpublished mimeograph, UCT | secondary literature compilation | 1987 | Supports the claim that import penetration ratios remained high and rose for machinery and motor vehicles and transport equipment. |
| Kaplan, D. (1983) 'South Africa's Changing Place in the World Economy', South African Review, One | secondary literature compilation | 1983 | Supplies the figure that South African investment abroad in 1980 exceeded one third of foreign investment into South Africa. |
| Black and Stanwix (1986) paper on crisis and restructuring in manufacturing (SALDRU workshop) | secondary literature compilation | 1986 | Supports the rising capital intensity of manufacturing and its dependence on imported capital equipment. |
Inference¶
Quantification: Descriptive tables.
Macroeconomic analysis combining descriptive time-series charts and one table of Reserve Bank aggregates with theoretical reasoning on exchange rates and distribution, close reading of the De Kock Commission reports, and comparison with liberalisation episodes in the Southern Cone and Israel. There is no formal statistical or econometric testing.
Key claims¶
| Claim | Basis | Strength |
|---|---|---|
| The current and capital accounts move in opposite directions over the business cycle. Gold-price and political shocks require severe adjustments hidden by the aggregates. (p. 2) | Reserve Bank Quarterly Bulletin series in Figures 1 and 2, read visually. | Partial data |
| Reliance on foreign loans increased South Africa's vulnerability. Indirect investment rose from 32 percent to 61 percent of total foreign investment between 1970 and 1984. (p. 4) | Cited figures with no stated source in the text, probably Reserve Bank data. The argument is partly narrative. | Partial data |
| Exchange rate policy has a downward bias that favours mining and agriculture and shifts income from wages to profits. (p. 5) | Theoretical argument (Diaz-Alejandro; Krugman and Taylor), the Figure 3 exchange rate series, and the Kleu report on import content. The bias is inferred rather than measured, and there are no wage or profit data. | Illustrative or anecdotal |
| Depreciation sharply raised the rand burden of foreign debt in 1983-84. Short-term debt rose to 72 percent of the total by 1985. (p. 6) | Reserve Bank debt data in Table 1. | Systematic data |
| Exchange controls leaked, especially in crises. Evasion is inferred from the jump in 'errors and unrecorded transactions' after 1976. (p. 9) | Balance of payments errors and omissions item compared with gross reserves. This is an indirect proxy and the author concedes not all of it is illegal. | Partial data |
| Liberalisation of exchange controls in 1981-83 encouraged unmonitored private foreign borrowing and increased vulnerability, and the controls had to be reimposed in 1985. Liberalisation is inappropriate for a country subject to political crises. (p. 8) | Table 1 debt data, a Euromoney interview quotation, De Kock Commission texts, and analogy with the Southern Cone and Israel. | Illustrative or anecdotal |
| Capital flight pressure rose because of declining profit rates and political uncertainty, which spurred local conglomerates to seek exchange control relaxation. (p. 10) | Asserted, with a single citation (Kaplan 1983) on the ratio of investment abroad. No profit-rate data or documentation of lobbying is given. | Asserted |
The author's caveats¶
The author notes that the 'errors and unrecorded transactions' item is not wholly illegal outflows. He also notes that it is impossible to say what outflows would have been without controls, and that the Reserve Bank stopped publishing the item separately in 1978, which makes its recent behaviour impossible to see.
Gaps in the evidence¶
The distributional claim that depreciation shifts income from wages to profits needs real wage, profit share and sectoral price series, such as national accounts and Reserve Bank data, which existed at the time. The capital flight and evasion arguments would be better tested with estimates of capital flight by residual or by company, and with data on corporate foreign borrowing. Event studies or cross-country comparisons of liberalisation could test the Southern Cone analogy. Figure 3's data source and construction are not stated.
Replicability: Data poorly documented.